The inflation-productivity trade-off revisited

Abstract

Our aim in this paper is threefold. First, to test the robustness of the relation between total factor productivity growth and inflation to the specification of the estimating model; second, to test the stability of their relationship in the short run and in the long run, and third, to investigate the direction of causality between these two variables. To accomplish the first objective, we estimate a generalized Box–Cox cost function using data from the two-digit Standard Industrial Classification of manufacturing industries in Greece during the period 1964–1980. The results show that: (a) the acceleration of inflation from 1964–1972 to 1973–1980 reduced total factor productivity growth in a way that was both statistically significant and sizeable, and (b) even when the effect of inflation is separated from the effects of technical change and economies of scale, the choice of functional form is most crucial. With respect to the second objective, somewhat to our surprise, we find that the inflation-productivity trade-off prevails even in the long run. And, finally, regarding the third objective, it emerges that in the great majority of two-digit manufacturing industries the causality runs from inflation to productivity. On these grounds we conclude that for a precise estimation of the relationship under consideration it is imperative to sort out the three effects involved, do so by adopting the most general flexible functional form for the cost function, and run the appropriate stability and causality tests.